Early in my career when I was studying for the Chartered Market Technician’s accreditation (CMT), the level 3 requirement was to write a thesis. Mine was based on a combination of fundamentals and technical inputs that I created to use in evaluating the bond market. It developed into an equity-based indicator in the early 2000s when my career transitioned to focus more on equity markets than bond markets. I wrote a weekly report based on it for years that went to clients of CIBC World Markets. When I left the bank in 2006 to start ETF Capital Management, the indicators for bonds and stocks were combined, given my global portfolio scope. Today, I’m launching the indicator I’ve named PRO-II (the Probable Return on Investment Index) or PRO-EYEs. I’ve been looking at some of the factors here in recent months.

It combines four equity valuation metrics, four business cycle influences, and 12 tactical market indicators, a few of which are in the CNN Fear and Greed Gauge Index.

Each week we will update the data on the Berman’s Call Blog here.

For each factor, I look back historically. The basis for the indicators is the U.S. stock market, specifically the S&P 500. It represents about 50 per cent of world equity capitalization, compared to the 3 per cent Canada represents. For indicators like seasonality, I go back to 1927. Others go back into the 1960s, ‘70s, or ‘80s. Others are newer like the VIX.  

I call it a probability index because I use a statistical method (Z-Score) that normalizes the factor into a confidence interval between 0 and 100 per cent, providing an apples-to-apples comparison over time. How far away from the average, or normal, is the index when measured in standard deviations. The higher the reading, the higher its caution level. The lower the indicator level, the more opportunity it offers towards future price movements. ETF Capital Management uses it to adjust risk levels in our portfolios. It does not select securities for us, it merely suggests the overall level of opportunity and caution in equity markets.

PRO-II Readings

Factor Z-Score Risk Level
Enterprise Value to EBITDA 3.38 100 per cent
Price-to-Sales 2.76 100 per cent
Forward P/E 1.87 97 per cent
Equity Risk Premium 1.16 88 per cent
Total Valuation:   96 per cent
Slope of Yield Curve 0.27 61 per cent
High Yield vs. Investment Grade Credit Spreads 1.31 90 per cent
NY Fed Weekly Leading Indicators -0.81 21 per cent
Real Yields & Inflation Expectations -1.2 12 per cent
Total Business Cycle Factor:   46 per cent
5-Day Put/Call Ratio 2.42 99 per cent
Speculative Position S&P 500 Futures -0.68 25 per cent
Percentage Deviation from 200-Day Moving Average 1.7 96 per cent
AAII Bull vs. Bear Sentiment Spread 0.84 80 per cent
Seasonal Pattern (All Years) Since 1928 0.49 69 per cent
Presidential Cycle (Current Year) Since 1928 0.33 63 per cent
Current vs. Average Volatility (VIX) 0.22 59 per cent
Current vs. Future Volatility (VIX) 0.41 66 per cent
Percentage of S&P 500 Holdings Above 50-Day Average 0.32 63 per cent
Percentage of S&P 500 Holdings Above 200-Day Average 1.18 88 per cent
Breadth-McClellan Summation Index 1.13 87 per cent
Overbought-Oversold 13-Week Relative Strength Index 0.61 73 per cent
Total Tactical Factor:   72 per cent
Total PRO-EYEs:   71 per cent

The bottom line is that no one knows, especially in a fear of missing out (FOMO) market like we are in today; one where central banks have resorted to printing money and governments have had to spend massive amounts to keep the economy going during the COVID-19 pandemic, how to value equities.

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Of the three segments of the overall index:


Overall valuation metrics are extreme. Historically, valuation is not a good timing factor, but it can leave indications on future average returns. At current levels, they are expected to be well below average with several periods of high negative returns. Corrections tends to be deeper when the economy weakens as earnings get squeezed and the multiple investors are willing to pay contracts. For conservative investors, one should have less sensitivity to economic weakness.

Business Cycle

Overall, the business cycle is completely distorted by central bank QE policy supporting the economy. Without it, the world would be in a deep depression. The biggest concern is the mispricing of financial assets and high-yield credit in particular. With central banks actively seeking inflation, there is a tipping point for long-duration financial assets leveraged to easy money. The Fed will have to keep stepping on the gas to keep business cycle conditions balanced at the risk of a stagflation outcome.


Overall, the tactical factor was weaker by about 6 per cent last week. The cooling came as markets pulled back a bit from recent highs without any broad technical weakness. The more elevated the indicator, the higher the short-term correction risk will be. Divergences are building in breadth indicators and with the weekly Relative Strength Index. This sign of decay suggests once a catalyst presents itself, like stimulus funding or possibly rising yields - markets may be at risk for a 5-to-10-per-cent correction.

The spring weekly Berman’s Call virtual roadshow will be back in March andApril. Subscribe to my new YouTube channel, which is the new site for all our educational content and my new weekly market recap and ETF bull and bear picks of the week. Look for a series of option based educational videos in 2021.

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